The| Advis or

May 2013

ESTATE PLANNER’S TIP Clients who make annual exclusion gifts to family members ($14,000 in 2013) should consider giv - ing appreciated stock, rather than cash. Clients in the top 39.6% income tax bracket ($400,000 for single taxpayers, $450,000 for joint filers) will pay a capital gains tax of 20% if they sell the shares, while younger family members may pay only 15% or even avoid capital gains tax entirely (tax - payers in the 15% and 10% tax brackets). There could be capital gains and net investment income tax savings of as much as 23.8% from a gift of appreciated stock to younger family members. Clients who aren’t in the 20% capital gains tax bracket may still avoid net investment income tax by transferring shares of appreciated stock. Taxpayers with modified adjusted gross income over $250,000 (joint filers) or $200,000 (single taxpayers) are subject to the 3.8% tax [Code §1411], in addi - tion to a 15% capital gains tax. Because these tax levels are not adjusted for inflation, there could be more clients subject to the 3.8% tax in future years.

GST LOST IN TRANSLATION

Lily, a foreign citizen, resides in the U.S. A tax is imposed on the transfer of the taxable Bernard, a non-resident, non-citizen, established estate of a non-resident non-citizen on that part of a trust in his native country naming Lily to the gross estate that is situated in the U.S. at death receive payments after his sister-in-law’s death. [Code §§2101(a), 2103]. Code §2601 imposes a tax The trust was initially funded with a residence on every generation-skipping transfer. Reg. located outside the U.S. The home was sold and §26.2663-2(b)(1) provides that a transfer by a non - the trust now consists of foreign currency, held by resident, non-citizen is a direct skip only to the a foreign trustee. Due to the high costs of trust extent that the transfer is subject to the federal estate administration and tax compliance, the trustee or gift tax under Reg. §26.2652-1(a)(2). The IRS would like to terminate the trust and make an determined that because Bernard’s home and the outright distribution to Lily. cash sale proceeds were not situated in the U.S., the Lily is more than 37½ years younger than transfers to the trust were not subject to federal gift Bernard but not more than 62½ years younger, mak - tax. The residue of his estate was not subject to the ing her a skip person for generation-skipping trans - federal estate tax. Therefore, the GST tax does not fer tax purposes under Code §§2651(d) and 2613. apply to the distribution to Lily (Ltr. Rul. 201311004).

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CHARITIES, INDIVIDUALS SHARE THE PAIN the ruling, noting that it was unclear that Fisher Warren Fisher’s will directed that his estate be would have wanted to follow the literal language divided into two shares. Part A was to be held for of the will if it meant completely disinheriting his his wife if she survived him (which she did not), nieces and nephews. The fact that Fisher named with assets passing at her death to several named specific individuals who would receive bequests charities. Part B was to be paid at his wife’s death only if they survived both Fisher and his wife indi - to 12 of his 21 nieces and nephews. cated that he sought to benefit those “with whom he had a relationship, rather than an entire class of At Fisher’s death in 2008, the Part A share was relatives.” Although the overall theme of Fisher’s $2,455,793. Between the date of death and estate plan was to reduce taxes, the court found August 2010, when the trustee was ready to dis - that he expected both Parts A and B to be funded. burse the assets, the stock market declined. The Applying the probable intent doctrine allowed value of the assets had fallen to $2,335,716, leav - both classes of beneficiaries to share in the reduc - ing insufficient assets to fully fund Part A and no tion in value caused by unforeseen market assets to fund Part B. changes, the court concluded ( In re Estate of Fisher , The bank trustee sought court approval to dis - Docket No. A-1889-11T1) . tribute all remaining assets to the Part A beneficia - ries, but the nieces and nephews objected. The court determined that Fisher had not foreseen the NO CHARITABLE STATUS FOR PETAL PUSHERS possibility that a significant drop in the value of Zagfly, a California corporation, sought assets would disinherit his nieces and nephews. §501(c)(3) charitable status. The company pro - The court reformed the will under the probable posed to sell flowers at retail price through its intent doctrine, directing that the remaining assets website and allow purchasers to designate a char - be divided in the same percentages as Parts A and itable recipient to receive the profits. It hoped to expand its offerings to include travel reservation B would have received if they had been estab - services. lished on the date of death. An organization is not considered charitable if One of the charitable beneficiaries of Part A more than “an insubstantial part” of its activities appealed, arguing that there was no ambiguity in is not in furtherance of its exempt purpose [Reg. the will. The Superior Court of New Jersey upheld §1.501(c)(3)-1(c)(1)]. A charity operating a trade or business may meet the requirements of Code §501(c)(3), but only if the trade or business is in PHILANTHROPY PUZZLER furtherance of the organization’s exempt purpose and if the organization is not operated for the pri - Clarence wants to create a charitable mary purpose of carrying on an unrelated trade remainder trust to benefit his grandchildren or business. Code §513(a) defines an unrelated for 20 years and then his favorite charity. The trade or business to include any trade or business grandchildren range in age from four to 18 that is not substantially related to performing the years. Clarence wants to serve as trustee so he can direct the income. His plan is to pro - charitable function. vide more help to each grandchild during his Zagfly argued that although it will engage in or her college years. Clarence’s advisor said activities that others engage in for “commercial his plan would have poor tax results. What gain,” its primary motive is charity. The primary is the problem? purpose will be to facilitate the donation of its profits to other charities. The Advisor

The Tax Court determined that Zagfly’s prima - CY PRES FOUND TO BE APPROPRIATE ry activity is a commercial venture that amounts The Edward John Noble Hospital of Gouverneur, to an unrelated trade or business. Selling flowers NY, was a residuary income beneficiary of three on the internet “is not substantially related to an testamentary trusts. Although the state department exempt purpose” under Code §501(c)(3), the of health had ordered the hospital’s lab closed, it con - court said ( Zagfly, Inc. v. Comm’r ., T.C. Memo. tinued to provide services through affiliates, in the 2013-29) . hopes of one day resuming full operations. Trustee’s fees are consuming most or all of the TITHING NOT “NECESSARY” SAYS TAX COURT income from the three trusts. The hospital asked George Thompson, who owed nearly $890,000 the court to apply the cy pres doctrine to allow the in taxes and penalties, was attempting to work out trusts to be used as collateral for loans that would an installment payment agreement with the IRS. allow the hospital to modernize its facilities. Thompson indicated that he had monthly income State law requires three conditions be met to of $27,633 and expenses of $24,416. Among the apply cy pres, including that the gift or trust be char - expenses were $2,342 per month for tithing and itable in nature, the donor have demonstrated a gen - church service expenses. The IRS settlement office eral charitable intent and that circumstances have determined that these were not “necessary expenses” changed making literal compliance “impossible or impracticable.” The court found all three testators in computing what Thompson could pay to the IRS. had general charitable intent to benefit the hospital Thompson claimed that the IRS officer abused and the residents of the community. Although the her discretion in classifying these as “conditional hospital is not claiming that literal application of the expenses.” Necessary expenses are the minimum trusts’ terms is impossible, they are impracticable. a taxpayer and family need to live. Conditional The court said there is little doubt, given the devo - expenses are not allowed in partial payment tion to the hospital that the three testators demon - installment agreements, noted the Tax Court. strated, that each would approve the changes pro - Thompson argued that classifying the church posed to insure that their charitable intentions were expenses as conditional violated his rights under met. Using trust corpus as collateral is appropriate the free exercise clause of the First Amendment. and will not divert the trusts to creditors’ claims, He said that his position in the church required added the court ( In re Edward John Noble Hospital of tithing, making it a necessary expense. A necessary Gouverneur , 2013 NY Slip Op 23016). expense is one that is required for the taxpayer’s health and welfare or for the production of income, said the court. Thompson’s position in the church PUZZLER SOLUTION does not pay him income, but he claimed that not There is nothing to prevent Clarence from being able to tithe would “negatively affect his implementing his plan, provided he (or his spiritual welfare,” therefore making it a necessary wife) doesn’t act as trustee. An independent expense. His failure to tithe will require him to trustee may be given the power to sprinkle resign his ministerial positions, he said. The court income among the grandchildren [Code acknowledged that he would have to resign, but §674(c)], but if Clarence retains the power to said that it is his church, not the IRS, that will apportion the income, he will be considered require his resignation. The IRS did not violate the owner of the trust under the grantor trust Thompson’s free exercise rights by classifying the rules [Code §§671-678], thereby disqualifying tithing as a conditional expense, ruled the court the charitable remainder trust. (Thompson v. Comm’r ., 140 T.C. No. 4) . The Advisor

BEATING EXEMPTION, DEDUCTION CUTBACKS

Limitations on personal exemptions and item - can transfer income-producing property to a trust ized deductions have made a return appearance that will pay charity income for five, ten, 20 years under the Taxpayer Relief Act of 2012. The cut - or longer, with assets passing to children when backs affect single taxpayers with adjusted gross the trust ends. During the term of the trust, the income above $250,000 and married couples with donor’s adjusted gross income is reduced (the AGI in excess of $300,000. The loss of tax benefits income the property earned is no longer taxable can be especially acute when clients sell highly to the donor). The donor benefits charity and, appreciated real estate or securities, particularly although there is no income tax charitable deduc - if they are also subject to the 20% capital gains tax tion, the gift creates income tax savings. It also rate and/or the 3.8% net investment income tax. eases the cutback on the itemized deductions and For charitably minded clients, there are several the phaseout of personal exemptions. Gift taxes tax saving strategies. are reduced in passing property to children. Charitable remainder unitrusts Qualified charitable distributions from IRAs The idea of selling capital gain property Distributions from IRAs are not subject to the through a charitable remainder unitrust has been 3.8% net investment income tax, but they increase around for a long time, but now the advantages AGI, exposing other investments to tax, and may are even better. Consider an unmarried client exacerbate cutbacks in personal exemptions and with AGI of $200,000 who owns appreciated itemized deductions. Clients age 70½ and older stock worth $250,000 (basis of $100,000). If the can direct that distributions from IRAs of up to client sells the stock it will trigger capital gains $100,000 be made directly to charity. To the tax of 15%, plus the 3.8% tax on net investment extent that these distributions take the place of income, and the client will also be subject to the required minimum distributions that would oth - cutbacks in both itemized deductions and per - erwise be fully taxable, the donor reduces taxes, sonal exemptions. If the client instead transfers even though no charitable deduction is available. the stock to a charitable remainder unitrust, he or Interest-free loans she avoids the 18.8% tax when the shares are sold Donors may lend up to $250,000 to charity, within the trust. In addition, the client’s AGI will interest-free, without running afoul of the imput - remain below the $250,000 threshold for the ed interest rules [Temp. Reg. §1.7872-5T(9)]. A deduction and exemption cutbacks. client who would otherwise lose some itemized Charitable lead trusts deductions and personal exemptions could Charitable contribution deductions cannot instead lend funds to a charity that would then reduce a donor’s adjusted gross income – only invest the money. Although no charitable deduc - taxable income. But a non-grantor charitable lead tion is allowed, the client reduces taxable interest trust can reduce a donor’s income taxes, avoid while the loan is in effect. The reduction in cutbacks and also cut down on gift taxes or estate adjusted gross income saves both itemized taxes in passing property to children. The donor deductions and personal exemptions.

BALL STATE UNIVERSITY FOUNDATION David W. Bahlmann, J.D. P.O. Box 672, Muncie, IN 47308 Philip M. Purcell, J.D. President/CEO (765) 285-8312 • (765) 285-7060 FAX Vice President for Planned Giving Toll Free (888) 235-0058 and Endowment Stewardship www.bsu.edu/bsufoundation If you know another professional advisor who would benefit from this publication, please contact The Foundation .